Mortgage types explained
There are two main types of mortgage.
These are repayment (capital and interest) mortgages, and
interest only mortgages. There are several different ways of
repaying interest only mortgages, and so interest only
mortgages have several different options available including
different investment options to pay off the mortgage, and
also different types of interest rate. The savings made can
differ substantially between the different types of
mortgages and between the different lenders.
Repayment Mortgage
The payments you make to the lender
every month pay off both the capital and the interest from
the mortgage. Provided you keep up the payments, you are
guaranteed to pay off the loan by the end of the term agreed
(between 20 and 25 years). You usually pay off more interest
at the start of the mortgage term and then gradually more of
the capital debt. Therefore, in later years, you will be
repaying increasing amounts of capital and reducing amounts
of interest. It may seem as if this is costing more but
that's because unlike the other types of mortgages you're
paying off the capital and not just the interest.
Interest-Only Mortgages
An interest-only mortgage is where the
lender only charges you interest on the loan you've agreed.
You don't pay the capital back until the end of the mortgage
term 25 years or whatever period agreed. The idea of this
mortgage is that you pay the interest owed to the lender and
save the capital repayments by investing them elsewhere. At
the end of the mortgage term you will have hopefully made
enough money from investments to pay the lump capital sum.
This way you can possibly make a saving by investing capital
that would otherwise be paid straight back to the mortgage
lender. The
lender may offer you an investment opportunity if you choose
an interest only mortgage such as an ISA. There are several
different types of interest-only mortgage
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Types of
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Variable Rate
The variable rate mortgage
was, until the 1980s, virtually the only type of
mortgage available. With a variable mortgage the
interest rate rises and falls (varies) according to
changes in the UK base rate. The base rate is set by the
Bank of England and lenders are free to decide for
themselves the amount they will alter their own interest
rates in response to a movement in the base rate.
Capped Rate
With a capped rate mortgage
you gain the security of having a 'cap', or upper limit,
to the amount that the interest on your variable rate
mortgage will rise for a specified period (typically
between one and five years). If the variable rate falls
your interest rate falls accordingly, although some
capped rate mortgages have a 'collar' or lower limit
below which your interest rate will not fall during the
capped rate period. At the end of this period, the
mortgage reverts to a variable rate.
Fixed Rate
With this type of mortgage
the rate of interest that you pay is fixed in advance
for a certain part of the term. Typically the period of
fixed rate will be between one and five years. After
this period, the mortgage reverts to a variable rate.
However, there are pitfalls with fixed rate mortgages,
particularly the redemption penalties that lenders may
attach.
Base Rate
Tracker
With a base rate tracker
mortgage however, the rate of interest you pay is tied
to the base rate set by the Bank of England. Typically
the tracker rate will be set as a percentage above the
base rate. The advantage is that if base rates fall, the
tracker rates will fall accordingly, no matter how low.
The downside is that if rates rise, a tracker mortgage
becomes less attractive than other mortgage types.
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Flexible
One of the newer facilities
offered with mortgages is the flexibility to vary the
amount of your repayments - both higher or lower, or
even to take a repayment holiday. This flexibility can
be applied to mortgage types such as variable, fixed and
capped rate products and is ideal for people whose
income varies during the course of the year.
Discounted Rate
With a discounted rate
mortgage, you gain a percentage discount on the standard
variable rate for a specified period (typically between
one and five years). This counts in your favour should
interest rates fall, but is not as attractive as other
mortgage types if rates rise sharply. You also need to
consider the redemption penalties that are sometimes
attached to this type of mortgage.
Cash
Back
With a cashback mortgage the
lender will give you a lump sum of cash at the start -
or sometimes during the term of - your mortgage. In
return, you typically have to agree to take the lender's
standard variable rate, and beware also that there are
usually redemption penalties attached to this type of
mortgage. A cashback facility can be added to other
mortgage types such as variable, fixed and capped rate
products.
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Non Status
Mortgage
(Adverse
credit mortgage)A non-status
mortgage is a mortgage that is offered to borrowers who do
not have to provide any proof of previous mortgage history
or any proof of income. In order to cover their risks, the
lenders will usually only offer non-status mortgages at a
loan to value of about 70%.
Remortgage
Remortgaging is no longer something
people do in desperate times. In fact it is becoming more
and more popular in the UK to remortgage as often as every
three years. By doing this you can take advantage of
mortgage lenders discounted rates used to attract new
customers
Buy to Let
mortgage
People looking for an alternative form
of long term investment and in many cases an alternative to
the pension have found buying to let a very desirable
option. Property is an extremely good investment, but it is
no longer limited to high income earners. With a buy to let
mortgage you can repay the mortgage using the rental income
meaning a buy to let mortgage is available to a larger
number of people than you might think. however a larger sum
of deposit is required this is usually around 20%- 25%.
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